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Income Statement Examples

Now that you're familiar with management accounting, let's look at an example of an income statement prepared according to GAAP, with significant subtotals, irregular items and EPS.

These are the account balances for Amalgamated Widget's Income Statement, in alphabetic order. The company has an average tax rate of 30%.

Account
Balance
Cost of goods sold
$ 4,500,000
Effect on prior years' income of change in method of computing depreciation
140,000 
Gain on condemnation of land
105,000 
Gain on sale of discontinued operation assets
455,000 
General and administrative expenses
920,000
Loss from earthquake damage
(175,000)
Loss on settlement of lawsuit
(80,000)
Net sales
8,000,000
Operating loss on discontinued operations
(210,000)
Selling expenses
1,500,000

First we separate the Operating Income and Non-operating items, and calculate the tax effect of each. In this example the lawsuit will be a significant item listed in the Operating section. Lawsuits are commonplace in business, so it is not considered extraordinary. However, because of the large dollar amount, such losses should be shown on their own line. This helps the user to better evaluate future results of operations.

In the example below I have calculated operating income before taxes, then I apply the 30% tax rate.

Operating Income    
Revenues    
Net sales  
$8,000,000
Expenses    
Cost of goods sold
$4,500,000
 
Selling expenses
1,500,000
 
General and administrative expenses
920,000
 
Loss on settlement of lawsuit
80,000
 
Total expenses  
7,000,000
Operating income before taxes  
1,000,000
Less: Income tax expense @ 30%  
300,000
Operating income  
$ 700,000
     

This chart shows one approach to calculating the needed amounts. In all cases the tax effect reduces the amount shown. Gains are made smaller because taxes have to be paid on them. Losses are reduced, because they reduce the total tax espouse; this is called a tax benefit.

Non-operating or Separately-stated Items      
Discontinued operations
Gross amount
30% tax
 Net of tax
Operating loss on discontinued operations
(210,000)
(63,000)
(147,000)
Gain on sale of discontinued operation assets
455,000 
136,500
318,500 
       
Extraordinary items      
Gain on condemnation of land
105,000 
31,500
73,500 
Loss from earthquake damage
(175,000)
(52,500)
(122,500)
       
Accounting principle changes      
Effect on prior years' income of change in method of computing depreciation
140,000 
42,000
98,000 
       

Having calculated all the needed amounts we just need to put them in the right order for an income statement. We will show some significant subtotals in blue because we will use them later when calculating Earnings Per Share. The company had 1,000,000 shares of common stock outstanding all year.

Amalgamated Widget, Inc.
Income Statement
For the year ended December 31, 2012

Net sales
$ 8,000,000
Costs and expenses  
Cost of goods sold $4,500,000
Selling expenses
1,500,000
General and administrative expenses
920,000
Loss on settlement of lawsuit
80,000
Income tax expense
300,000
Total costs and expenses
7,300,000
Income from continuing operations
700,000
Discontinued operations
Operating loss on discontinued operations (net of $63,000 income tax benefit)
(147,000)
Gain on sale of assets of discontinued operation (net of $136,500 income tax)
318,500
171,500
Income before extraordinary items and cumulative effect of accounting change
871,500
Extraordinary losses    
Gain on condemnation of land (net of $31,500 income tax)
73,500
Loss from earthquake damage (net of $52,500 income tax benefit)
(122,500)
Effect on prior years' income due to change in method of computing depreciation (net of $42,000 income tax)
98,000
Net Income
 $   920,500 =======
Earnings per share of common stock    
Income from continuing operations
$ 0.7000 
Gain on Discontinued operations
0.1715 
Earnings before extraordinary items and cumulative effect of accounting change
0.8715 
Extraordinary Gain on condemnation of land
0.0735 
Extraordinary Loss from earthquake damage
(0.1225)
Cumulative effect of accounting change (gain)
0.0980 
Net Income
$ 0.9205 
===== 

Of course, the Income Statement will be modified to show only the items that actually happened in any given year. There is no need to put a line on the statement for something that didn't happen. IF the company has any of these three items, they would be disclosed as shown above. These are called irregular items, because they don't happen very often.

Significant subtotals

Several significant subtotals must be included in the income statement. These are indicated in blue in these examples. These subtotals help investors evaluate the company's past performance and predict and estimate it's future prospects.

Earnings Per Share

All Income Statements must show Earnings Per Share for each significant subtotal item, starting with Income from continuing operations. The significant ones are the amounts in the far right column in the statement.

Calculating EPS

EPS is calculated for common stock only. If a company has both common and preferred stock, any preferred dividends must first be deducted from Income from continuing operations and Net Income, before calculating EPS.

EPS = Earnings available to common stock / Outstanding shares of common stock

An outstanding share is one in the hands of an investor. If a company has Treasury Stock, those share are not outstanding, no dividend is paid on them, and they don't figure in to EPS.

In most cases, the company will have the same number of shares of common stock outstanding all year. In these cases, calculating EPS is an easy job. But in some cases the number of shares outstanding may change during the year. If that happens we use the weighted average method.

Weighted average might be a complex calculation if the company issued new shares during the year, on many different days. The company may also have Treasury stock transactions, which changes the number of outstanding shares. Since dividends are not paid on Treasury stock, these shares are also not included in calculating EPS. Generally this is not the case, but let's look at a simple example of a weighted average.

A company has 100,000 shares of stock outstanding for the entire year. On July 1 it issues an additional 50,000 shares.

Weighted Average Shares of Common Stock

100,000 shares x 6/12 of a year
50,000
150,000 shares x 6/12 of a year
75,000
Weighted average number of shares (add)
125,000

This is a simple example, and you could use a decimal instead of a fraction. You could also have more than two parts, if there was a change in outstanding shares on more than one occasion. If there is no change in outstanding shares, you don't need to do this calculation.

Once you have the number of shares figured out, all you need to do is divide to calculate the EPS for each item in the list above.

Calculating Preferred Dividends

Preferred dividends are paid on preferred stock (Pfd). This type of stock carries special privileges and features. Preferred stockholders are in line for dividends before common stockholders. If all the retained earnings and cash are used up to pay preferred dividends, then there is nothing available for the common stockholders. So we deduct Pfd dividends when calculating EPS on common stock.

It is fairly easy to calculate the preferred dividends. You need to know the number of shares of Pfd stock, and the amount of the dividend, which will always be stated. If the Pfd stock has a dollar amount, that is the dividend to be paid each year, per share. If the Pfd stock has a percentage, multiply the par value per share times the percentage to get the dividend. Here are two examples. Assume the company has 5,000 shares of preferred stock.

$6.25, $100 par preferred stock
$7%, $100 par preferred stock
Dividend = $6.25 per share
$100 x 7% = $7.00 per share dividend
Total = $6.25 x 5,000 = $31,250
Total = $7.00 x 5,000 = $35,000

Types of Dividends

Cash Dividend: a payment of Cash to the stockholders

Stock Dividend: transfer or issue of additional stock certificates to the stockholders

Property Dividend: transfer of company property to the stockholders

Liquidating Dividend: a return of capital; comes out of paid-in capital, not RE

Cash Dividends

Dividends must first be declared by the Board of Directors. Dividends are recorded (entry dated) in the books on the day they are declared. The Board of Directors must examine the Retained Earnings account and determine how much dividends could be paid. In this example, the RE account has a Credit balance of $20,000 so this will the maximum amount of dividends they would be able to declare.

It is unlikely a company would declare all the retained earnings as dividends. As discussed above, they would also have to consider cash needs of the company for the coming months ahead and see if they are able to pay a dividend at all.

Retained Earnings

 Date  Description
 Debit
 Credit
Balance
 Dec-31        (20,000)
         
         

Let's assume the Board of Directors declared a $10,000 cash dividend on December 31. It can take a month or more to prepare dividend payments to all stockholders in a large corporation. When dividends are declared, we write a journal entry, as follows:

Date
Account
Debit
Credit
  Dec-31
 Cash Dividends
 $10,000
 
     Dividends Payable  
 $10,000
       

In this example I debited Cash Dividends, to differentiate this type of dividend from other types. Companies often simply debit a Dividends account for all dividend transactions. Either way is acceptable. When the dividend checks are prepared and mailed to the stockholders we record the following entry, to eliminate the payable.

Date
Account
Debit
Credit
  Jan-31
 Dividends Payable
 $10,000
 
     Cash  
 $10,000
       

The Dividend accounts are closed to Retained Earnings at the end of the year. Companies also have the option to directly deduct the dividend from Retained Earnings on the day the dividend is declared. Some company's follow this procedure. In that case the first entry would look like this:

Date
Account
Debit
Credit
  Dec-31
 Retained Earnings
 $10,000
 
     Dividends Payable  
 $10,000
       

Different textbooks will show these two methods. The company's accounting managers will generally decide which method the company will use. You must always remember that an accounting system is tailored to the needs of the company using it. GAAP deals with disclosure of information in financial statements, not with bookkeeping procedures. Different bookkeeping procedures may be equally acceptable, as long as the financial statements are prepared according to GAAP.

Stock Dividends

Stock dividends are paid for various reasons. Sometimes they are paid because the company has adequate Retained Earnings, but not the cash to make a dividend payment. Stockholders are often very happy to have more shares of stock, rather than money. Stock dividends are not taxed until the stock is sold; tax on cash dividends must be paid in the year the dividend was received. So taxes on a stock dividend become deferred to a future year, which many investors see as an advantage.

Stock dividends are declared in the same way as cash dividends. However, the company is issuing stock, so we will credit the common Stock account, and perhaps the Additional Paid-In Capital (APIC) account. If you're not up to speed on journal entries for stock issues you should review the lesson on stockholders' equity.

Stock dividends are directly linked to the market price of the stock. The market value of a stock dividend is transferred from the RE account to the Common Stock and APIC accounts, to record the issuance of the shares. Let's assume that stock is trading for $25 per share, and has a par value of $1. The journal entry for one share would be:

Date
Account
Debit
Credit
  Jan-31
 Retained Earnings
 $25
 
     Common Stock  
 $1
     Additional Paid-In Capital  
 $24

Of course, you would determine the total number of shares to be distributed, and write a journal entry to match. If 1000 shares were to be distributed, you would multiply each of the numbers above by 1000.

Prior Period Adjustments

A prior period adjustment is one that relates to a previous fiscal year that has already been closed - closing entries have been posted, and financial statements have been prepared and released. Sometimes after the year end we discover a material error that would have effected net income of the prior period. When this happens, we make an adjusting journal entry to Retained Earnings to correct the problem.

We have to report the situation in the financial statements and this is done by showing an adjustment to the beginning balance of Retained Earnings. After RE has been restated, the current year's activity is reported on. Your textbook has a good example of how this is shown in a Statement of Retained Earnings.